This could be great news for investors. With the vast majority of Australian portfolios top-heavy in domestic equities, property and cash, more and more investors are keen to diversify their holdings. It’s just a matter of how much risk they’re willing to take on.

Here, we take a look at some different forms of equity funding – exploring the pros and cons for entrepreneur and investor alike.

1. Crowd-sourced funding

The entrepreneur

Crowd-sourced funding got the official green light from the Australian Government in late 2017. The new regulations now allow start-up companies to raise business start-up costs from a large group of retail investors, each typically investing small amounts of money.

Under the government’s rules, eligible businesses can raise up to $5 million a year using crowd-sourced funding. However, they must have less than $25 million in assets and annual revenue.

“Raising capital using a crowd-sourced funding platform can be a useful way to fund a growing business,” NAB Ventures General Partner Melissa Widner says. “Not only is it a relatively low-maintenance way to access capital compared to going public, but new investors may become company advocates, which can be especially beneficial for consumer products enterprises.”

The investor

Crowd-sourced funding appears to offer a relatively simple way to invest in start-ups. Nevertheless, the attendant risks mean the government is keen to carefully regulate this area. According to the Smart Money website, there are a number of procedures you must adhere to, including:

If you want to invest in a company offering shares through a crowd-sourced funding website, you must apply through that website. Furthermore it should be run by a licensed intermediary.

Before you can apply, you’ll be asked to acknowledge that you’ve read and understood the risk warning listed on the website and in the offer document.

You can only invest up to $10,000 per company in a 12-month period. So your application will be rejected if you try to invest more than the cap.

You have a cooling-off period of five business days to change your mind if you decide the investment isn’t for you. You can find more information on crowd-sourced funding at moneysmart.gov.au.

2. Angel investors

The entrepreneur

Angel investors provide capital investment in very early-stage start-ups in exchange for equity.

According to Widner, there are more opportunities than ever in this space. “There’s never been a better time. A lot of angel groups have formed [over the past few years] and there are many examples of people getting together and pooling their money to make single investments.”

The type of businesses to attract angel funding can vary considerably – from artisan bakeries to superannuation. However, most will have a high-growth component, Widner says. Indeed, more often than not, they’ll be a biotech or technology business.

The investor

A large number of active angel investors are successful business owners or people who have recently exited a business, Widner says. “We’re seeing a lot of the SME [small and medium-sized enterprise] business owners out there becoming angels and getting quite interested in this space.”

They don’t do it for the returns, however. “It’s a high-risk asset and if it works well, the returns are great. But the value for most angels is in working with entrepreneurs,” Widner explains. “A lot of them are entrepreneurs themselves. They got their wealth through entrepreneurship, so they love being around entrepreneurs, they love being part of the journey.” For most, she adds, it’s a hobby.

The amount invested can vary, but it doesn’t have to be in the hundreds of thousands.

“We see a lot of people investing $25,000 because they’re interested in the company.”

3. Venture funding

The entrepreneur

Venture funding is all about financing start-up or emerging businesses that are considered to have long-term growth potential. While still small, it’s growing in Australia.

“Venture funding has grown almost 15-fold in Australia since 2011 and there are several funds well over $100 million that have been formed in the past couple of years,” Widner says.

That doesn’t mean it’s a sure thing for your up-and-coming business, however. In reality, only a handful of small businesses are venture funded each year in Australia.

To date, it remains the preserve of high-growth businesses.

“Venture has to go for really big returns,” Widner explains. “That usually means technology companies that can’t raise debt because they’re not going to be profitable for a long time.”

The investor

Venture funding may not be the place for regular investors, either. Nevertheless, opportunities are appearing for high-net-worth individuals. There’s an interest there, Widner confirms, and it may be that, with time, Australia will get closer to the United States in this respect.

“In the venture fund I worked for in the US, even if 75 per cent of our capital came from institutions, most of our investors were individuals.”

Again, for these individuals it was the venture space rather than the promise of huge returns that was the attraction.

“They liked being in this asset class. It was really interesting for them to see how we invested and to meet with the entrepreneurs.”

Buyer beware

NAB Ventures General Partner Melissa Widner emphasises that while investing directly in a start-up or early-stage venture can be very rewarding, it’s a high-risk game, and its attendant risks cannot be overstated.

As NAB Private Customer Executive Jason Murray points out, if investors are keen to diversify their portfolios, they could invest in exchange traded funds instead. They’re listed funds that give you indirect exposure to a whole raft of assets, from international technology-related shares to currencies and commodities.

Important differences

It’s worth noting that crowd-sourced funding of shares is not the same thing as the donation-based crowd funding. Donation based crowd funding is typically used by artists or entrepreneurs to raise money for one-off projects. Those are donations only, with no equity element.

Important information

The information provided in this article is intended to be of a general nature only. It has been prepared without taking into account your objectives, financial situation or needs. Before acting on the information in this article, National Australia Bank Limited (ABN 12 004 044 937, AFSL and Australian Credit License 230686) (NAB) recommends you consider whether it is appropriate for your objectives, financial situation and needs. NAB recommends that you seek independent advice before acting on any information in this article.

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